Question

1. You have a coupon bond that has 30 years to maturity. You want to split the coupons and Principal and sell these two assets to your investors. We will call the asset with all the coupons as C-Strip and the asset with Principal as P-Strip.

a. Between C-Strip and P-Strip which will be priced higher if all the payments are from the bond? Why?

b. Suppose you purchase multiple bonds of the same kind and make the PV of C-Strips and P-Strips to be equal. If interest rate changes, which will be more sensitive in terms of value change? Why?

2. Suppose there are two different kinds of bonds on the market: Old and New bonds. Both bonds are issued by the same company and have identical coupons, principal, and the same initial maturity (both 30-year bonds). The Old bonds were issued 10 years ago and the New bonds were just issued. If you are expecting that the market interest rate will fall very soon. Which bond will be more attractive for you if you are to sell the bond shortly?

3. Suppose there are two different kinds of bonds on the market: High-C and LowC bonds. Both bonds are issued by the same company and have identical principal, and the same initial maturity (both 30-year bonds). The High-C bonds were just issued with a high coupon rate and the Low-C bonds were just issued with a low coupon rates. If you are expecting that the market interest rate will fall very soon. Which bond will be more attractive for you if you are to sell the bond shortly?

4. Suppose there are two different kinds of bonds on the market: High-Y and LowY bonds. Both bonds are issued by the same company and have identical coupons, principal, and the same initial maturity (both 30-year bonds). The High-Y bonds were just issued in a country A that has high interest rate and the Low-Y bonds were just issued in a country B that has low interest rate. If you are expecting that the market interest rate will fall very soon. Which bond will be more attractive for you if you are to sell the bond shortly?

5. Interest rates often reflect how the economy is doing (high interest rates may reflect high growth rate). Suppose that there is a convertible bond outstanding on the market. When do you think it will be converted into stock more frequently 1) when interest rate goes up vs. 2) when interest rate goes down.

Answer 1

1. Treasure STRIPs are bonds that are sold at a discount on their face value. The investor does not receive interest payments but is paid back the full face value when the bonds maturity. That is, they ripen "par."
STRIPS is a acronym for Separating the Variable of Registered Interest and Security Head. These types of bonds are generally known as zero-coupon bonds because they do not pay interest, or coupon.

2. There is a greater chance that interest rates will rise (and thus adversely affect the market price of the bond) in the longer term than in the short term. As a result, investors who buy long-term bonds but then try to sell them before maturity may face a significantly reduced market price when they want to sell their bonds.

3. High coupon bond would be more attractive for us because as both are just issued and the prices of both bonds will fall soon so by selling the high yield bond we can get good amount of profit

4. High yield bond which has high interest rate because as the market interest rate will fall soon then the bond with high interest rate is much more profitable than that of low interest rate.

5. If the stock price goes up significantly, the investor can convert the bond into stock and hold or sell the stock at their discretion. Ideally, the investor wants to convert the bond into stock when the net sale value of the stock exceeds the face value of the bond above the residual interest payment.